Financial Evaluation: Are Financial Statements beneficial to small business?
As we work our way through the seven steps to getting your business finances 100% in order – as laid out in The Essential Finance Handbook For Entrepreneurs, financial statements cannot be ignored.
The first step was about setting your financial goals.
The second step was about selecting an appropriate structure for your business.
The third step was understanding your legal obligations as a business owner, and the fourth step was understanding finance as a core business function.
The fifth step pertains to understanding the key role players in financial reporting.
The sixth step covers the development of sound financial controls and systems, to ensure that you have a sound grip on your business.
The seventh and final step addresses financial evaluation, which includes financial statement analysis and interpretation.
Why are financial statements important?Financial statements show the financial status of your company. Click To Tweet
Monitoring the financial health of your business can make the difference between failure and success.
For example, properly scrutinizing financial statements will stop you from spending money that you do not have and also let you know when you can deploy funds to take your business to the next level.
- Primary Financial Statements
There are three primary financial statements: the balance sheet, the income statement and the cash flow statement. The balance sheet demonstrates the basic accounting equation: Assets = Liabilities + Owner’s Equity. Assets include everything of value that a business owns or is owed, and liabilities are what a business owes. Owner’s equity — the balance left over after you subtract liabilities from assets — is the owner’s share of the business. The income statement, also known as the profit and loss statement, shows the profitability, or lack thereof, of a business over a set period. The cash flow statement converts finances from accrual basis to cash basis and measures the flow of cash in and out of the business.
- Decision-Making Tools
Financial statements are decision-making tools, because they help you to see a snapshot of your company’s financial position. Financial statements show business trends, the rate at which you are collecting receivables, the rate at which you are paying creditors and any cash flow problems.
The following are examples of questions you need answered as you make strategic decisions on how to make your business successful. You can use the accounts receivable report to determine which customers are in good standing, are in need of collection efforts or have uncollectible debt (if an invoice has not been paid within six months, after collection efforts). Accounts payables reports let you know what is owed to whom and when. You can also generate reports to let you know what your inventory levels are and the value of the inventory. You can generate a report to answer almost any question you have about your business that relates to what you own, what you owe and how much money your company makes.
- Necessary to Get Credit
Numerous businesses need credit as a part of their strategy to remain financially viable. Businesses apply for business loans, business credit cards and credit terms with a vendor. In almost all situations, the lender will ask to see a balance sheet and run your credit report to decide whether to loan you credit. A balance sheet will show a creditor how much debt you are carrying and how much money is flowing in and out of your business. In addition to the financial statements you hand over, an internal accounts payable report helps you to pay your bills on time and keep your company’s credit score high, so you remain a good credit risk.
- You Need Them for Compliance
You need financial statements to calculate your tax obligations. Tax obligations include VAT and annual taxes. A VAT report separates amounts that include VAT from those amounts that do not receive VAT and will provide you the information you need to pay the VAT you collected from customers. Government tax obligations include payroll-related taxes and annual taxes. A payroll liability report will outline all your payroll-related obligations, not only to the government but also for benefits.
If you are ever audited, you must be able to provide documentation of the information reported in your tax filings. Acceptable documentation is financial statements, beginning with the primary financial statements and any additional statements auditors request. You must be able to back up the statements with hard records such as receipts and pay stubs. To prepare annual taxes, you begin with the primary financial statements. You may find that you need to run additional reports to generate the specific information you need to fill out your tax forms.
What are the Advantages of Financial Statement Analysis?
For most small-business owners, analysing financial statements might seem overwhelming. While many business owners might outsource the creation of financial statements to an accountant, learning to analyse them helps determine the financial health of your company. Financial statements should be analysed once a year, if not quarterly, to take full advantage of the information they offer.
- A Cash Flow Review
A cash flow statement accounts for money flowing into and out of the business. It shows the financial solvency of a company to pay its liabilities at any point in time. Some companies have cyclical revenues but consistent expenses. Knowing that the Christmas rush needs to fund a slow first quarter of expenses is important for business owners to manage financial resources.
- An Inventory Review
Assets are included on the balance sheet. Analysing whether there is too much inventory or too little, helps business owners prepare for upcoming sales months. Keeping too much inventory on hand is a potential problem that ties up money, while not having enough inventory can lead to losing customers and market share.
- A Review of Liabilities
The financial statements show the existing liabilities. These include business loans, lines of credit, credit cards and credit extended from vendors. A business owner who is planning to apply for a business expansion loan can look at the financial statements and determine if he needs to reduce existing liabilities before applying. Lenders look at the financial statements and consider the revenues, assets and existing liabilities.
- Identifying Trends
Analysing the financial statements from quarter to quarter and year to year help business owners see trends in growth. A young business might have losses in the early years while it is developing products and a customer base. At the same time, statements show whether the business owner is meeting projected estimates. If a business is projecting a 10 percent annual growth but only achieving 7 percent, business leaders need to look for ways to either cut costs or increase revenues. The financial statement identifies the information to explore further.
- Access to Credit
When a business seeks partners or investors, the financial statements are critical. Analysing the statements not only helps investors determine if a company is making money, but it also helps to identify a reasonable cost per share. Shareholders usually invest capital in a company for growth; thus, shareholder equity is defined based on the capital investment added to assets, with liabilities subtracted, to define total shareholder equity.
Financial analysis is crucial for any small-business owner, as they weigh the effect certain decisions, such as borrowing, will have on their companies.
By employing expert financial analysis on an ongoing basis, you are able to make investment decisions or recommendations based on sound reasoning.